Judge Jacksons ruling in the Microsoft antitrust trial relied heavily on theories of market lock-in, which allege that competition is lax in industries that exhibit increasing returns due to network effects. WINNERS, LOSERS & MICROSOFT, first published in 1999, shows that lock-in theories are theoretically flawed and empirically unfounded.

This revised edition of WINNERS, LOSERS & MICROSOFT includes an extensive analysis of Judge Jacksons findings, showing how they fail to overcome Liebowitz and Margoliss powerful critique of lock-in theory, including the cases of the QWERTY typewriter keyboard, the VHS video tape format (over the supposedly superior Beta format), and Microsofts operating system. It also shows that the proposal to split Microsoft into separate companies (Applications and Operating Systems), and ban them from working together for ten years, would impose costs on consumers, and waste on the industry, while reducing competitive and innovative.

Judge Jackson argued that the Microsoft Windows operating system owes its market success to the fact that so many applications are written for it. But this lock-in theory (or applications barrier to entry, as the judge called it) is hard to reconcile with the fact that Windows beat out IBMs OS/2, which included a browser, had many applications written for it, and was substantially similar to Windows.

Jackson contended that Microsoft sought to protect an effective monopoly in desktop operating systems by reducing Netscapes considerable market share. Jackson assumed that Java applications might someday operate off of Netscape, thereby making the underlying operating system irrelevant. But this premise requires a leap of faith, say Liebowitz and Margolis: No middleware program has ever become a platform for mainstream programs or a serious alternative to an operating system.

Would breaking up Microsoft strengthen alternative operating systems or help create new ones? History suggests otherwise. To date, no major desktop applications have been profitably ported to Linux. And never has a dominant application in an important market prompted a movement toward an OS function for that application. Thus, there is no evidence to support Judge Jacksons claim that a separate Microsoft Applications would undermine the market share of Windows.

The Justice Departments expert acknowledged that breaking up Microsoft would likely result in higher prices because there would exist two profit-maximizing companies making complementary products instead of one. More importantly, there is no guarantee that the two companies would both employ the low-price, high-volume strategy that Microsoft has employed.

Judge Jacksons provision to allow computer makers (for three years) to choose which components of Windows to install on their computers threatens consumer welfare by eliminating the efficiencies that come from having standardized operating system. Computer makers would not be required to disclose to consumers when they are selling threadbare versions of Windows.

Judge Jacksons no-trade clause between Microsoft Applications and Windows threatens to reduce innovation in Windows. For example, efficiency would likely be improved by allowing Windows to incorporate voice-recognition code, but under Judge Jacksons proposal, Windows and Microsoft Applications would be prohibited from working together to produce complementary voice-recognition products.

Microsofts current dominance in software markets is not evidence of an illegal monopoly: In markets where Microsoft dominates, it has the best products based on independent reviews and evaluations. Where it does not dominate, other firms have superior products.

Software prices fall dramatically in markets where Microsoft is a major player: If Microsoft is not a factor, prices show no strong tendency to fall over time.

Assertions that technology industries get locked-into low quality products are unfounded: These include claims that Beta was better than VHS, that QWERTY was a bad keyboard designed to slow down typing, and that DOS was a poor operating system.

In high-tech markets, good products replace bad ones very quickly: Surveys of magazine reviews show conclusively that Excel was considered superior to Lotus 1-2-3 and that Microsoft Word for Windows was recognized as a clearly superior product to WordPerfect.

Where its products have been inferior, Microsoft has failed: Microsoft Money has not taken market share from Quicken, which gets the best reviews for personal finance software. In online services, the Microsoft Network (which consistently scores poorly in reviews) has seen AOLs market lead grow by 30 points in two years.

Synopsis

The mousetrap principlebuild a better mousetrap, and the world will beat a path to your dooris one of the basic assumptions of our economy.

Recently, however, new theories that have percolated in academic writing and into public policy have questioned this principle. Some people believe a property known as path dependence can lock-in inferior products and lock-out innovative newcomers. Many feel that Microsoft is a prime example of a company triumphing through such path dependence.

In WINNERS, LOSERS & MICROSOFT: Competition and Antitrust in High Technology, Stanley Liebowitz and Stephen Margolis examine the theory and evidence of path dependence, and assess whether Microsoft and other highly successful high technology companies have made use of lock-in. Their conclusions are surprising. Instead of lock-in, they find that competitive advantages in high tech are short-lived and temporary. The best way to promote competition and innovation, they conclude, is not through antitrust action but instead by relying on the competitive entrepreneurship of free markets. The result is a book that is both a superb examination of the economics of information technology and a case study of how government policies solely based on abstract theories devoid of solid empirical evidence can produce great harm.

Lock-In, Path Dependence and QWERTY

In a nutshell, lock-in supposedly happens when many other people use the same product (like a telephone or VCR) and it becomes a de facto standard. Network effects from this standard (such as more movies being available on VHS if VHS is the most widely used standard) mean consumers want products adhering to that standard. Consumers will be reluctant to try new products diverging from the standard.

This possibility is the problem that path dependence theory alleges. It is this exception to the mousetrap principle. The lock-in problem is said to explain the success of the everyday QWERTY typewriter keyboard, the VHS video tape format (over the supposedly superior Beta format), and Microsoft s operating system.

Thats the theory. But does the real-world evidence support the theory? In WINNERS, LOSERS & MICROSOFT,Liebowitz and Margolis begin with a survey of various path dependence claims, and find that almost all are little more than urban legends. Especially dramatic is their exposé of the myth of the Dvorak keyboard. That myth holds that the QWERTY keyboard that most of us use is terribly less efficient than the Dvorak keyboard, which was developed about seventy years later. According to the myth, the superior Dvorak keyboard was locked-out because of the domination of QWERTY. However, Liebowitz and Margolis conclusively show the Dvorak keyboard offers no advantage over QWERTY, and claims for Dvorak s superiority are mainly based on spurious research by someone with a financial interest in the success of the Dvorak keyboard.

Gaps in the Logic of Lock-In

Leibowitz and Margolis show why true examples of harmful lock-in are very hard to find. Path dependence theories, the authors show, leave out important steps real people take to deal with real problems. Foresight, communication among consumers, consumer magazines, marketing efforts, moneyback guarantees and other entrepreneurial efforts all work to prevent lock-in. If we all really knew that a new product was sufficiently better, and we all knew that we all knew, wouldnt someone find a way to help us switch? Liebowitz and Margolis argue it is extremely likely that someone would, especially since in doing so, there will be money to be made.

Do Real Markets Lock-In Inferior Products?

WINNERS, LOSERS & MICROSOFT looks at evidence from the real world. First, it considers a number of the cases alleged to demonstrate that lock-in occurs. The competition between Beta and VHS is examined, followed by the battle between the Macintosh and the IBM PC and several other rivalries. Liebowitz and Margolis show that in case after case, alleged lock-ins are not really lock-ins at all.

The authors then examine the market for personal computer software the focus of the decade s most infamous antitrust case and a key reason for the attention paid to path dependence theories. This industry has networks, an urge for compatibility, and ordinary economies of scale all of the preconditions of lock-in. Surely, if theories of networks, lock-in, or path dependence apply anywhere, they ought to apply here.

Liebowitz and Margolis draw on market data on product sales, as well as a large body of independent product reviews, to show several important results. Areas examined include spreadsheets, word processors, office suites, desk-top publishing, tax financial packages and browsers.

Applications software markets, the authors note, are often dominated by a single product. That finding, which should not surprise anyone, is consistent with network effects increasing returns. But the book also demonstrates two important points that may be surprising. First, while these markets do tend to be dominated by a single firm, market leaders are often replaced and the replacement often occurs with astonishing speed. Second, replacement occurs when a product comes along that is clearly superior, as revealed in product reviews in the leading personal computer magazines. These circumstances are nothing like lock-in.

Another surprise is what happens in markets with locked-in leaders. Traditional structuralist views of economics, as well as theories of lock-in, predict that locked-in market leaders could, and would, raise their prices. However, prices do not seem to rise as market leader is established.

Microsoft and Antitrust

Of particular relevance to current antitrust controversies, Liebowitz and Margolis find that, in markets in which Microsoft has an important presence, prices fall more rapidly than in other applications markets. Further, in the market for Macintosh applications, which Microsoft dominated very early, prices for Microsofts applications have been lower than they have been in the Windows applications market.

Liebowitz and Margolis also examine several antitrust issues raised in the Microsoft case. Among other things, they argue that bundling of software a key issue in the Microsoft case is unlikely to be a profitable strategy unless it provides consumer benefits. They also argue that adding functionality to software (which is what bundling is) is a fundamental and inevitable characteristic of progress in this industry.

They also consider the highly speculative claim that Microsofts position in the software industry is a threat to innovation. Leibowitz and Margolis conclude that the real threat to progress is an environment in which government rules determine what can and what cannot be included in software products.

Finally, they note that elevated prices and restricted output are the monopoly harm that antitrust might constructively address. These conditions are not present in the personal computer software industry.

WINNERS, LOSERS & MICROSOFT is a fresh, thought-provoking, and powerful look at how high technology markets really work and the true dynamics of high technology innovation and competition.

About the Authors

Stan J. Liebowitz is Professor of Managerial Economics at the University of Texas, Dallas.

Stephen E. Margolis is Professor of Economics and Business at North Carolina State University.